Britain's Liberal Democrat leader Nick Clegg speaks to the media outside his home in London on Tuesday. Clegg says he is anxious to resolve Britain's political impasse and hopes his party can make an announcement on its decision as quickly as possible.

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London

After a knife-edge election in which no party emerged as the outright victor, talks aimed at forming Britain’s next government intensified Tuesday amid widespread expectations of a conclusion by the end of the day.

A deal between the two sides had seemed almost certain until Monday night’s game-changing announcement by Prime Minister Gordon Brown that he would be stepping down within months – removing one of the biggest stumbling blocks to the ability of the Labour party to win the support of the Liberals.

Bidding war

The result? The formation of Britain’s next government has become the subject of a bidding war in which the Liberal Democrats are playing the two parties off against each other, with the smaller party still dreaming of changing the electoral system in order to end their days on the political fringe.

“I would have said on Monday that I would have been 80 percent confident that we were moving rapidly towards a Liberal–Conservative coalition,” says Mark Littlewood, current director general of the Institute of Economic Affairs and former head of media for the Liberal Democrats between December 2004 and May 2007.

After Mr. Brown’s resignation, Mr. Littlewood is now “slightly more than 50 percent” sure that such a pact will take shape, but warns that his former party’s renewed talks with Labour are trying the Conservative Party’s patience.

The Liberal Democrats want Britain’s voting system to be changed to a form of proportional representation, which would greatly increase their future seats in Parliament. Under the current system, the Liberal Democrats won almost a quarter of the overall vote last Thursday. But that earned only 9 percent of the parliamentary seats.

On Monday, the Tories made a limited counteroffer to the Liberal Democrats of a referendum on a less dramatic type of electoral reform.

However, it remains unclear if the Conservatives would campaign for the change. The third party is also seeking to extract an agreement from Labour that the electoral system would be changed by parliamentary legislation, bypassing the need to go to the public.

Lib-Lab coalition?

A so-called Lib-Lab coalition comes with two major dangers.

Some wonder if it would be regarded as an affront to the will of the voting public, who gave the Conservatives 306 of parliament's 650 seats, just short of the 326 needed for a majority. Labour won 258 seats, Liberal Democrats won 57, and smaller parties took the rest.

The other problem, and one that comes with practical implications for Britain’s efforts to navigate the exceedingly choppy economic, is that such an alliance would still need the votes of a range of other parties to govern as a majority in parliament. They include the Scottish nationalists, who are rivals to the Liberal Democrats in Scotland.

A "Lib-Con" alliance on the other hand would constitute a clear majority of at least 37.

“The truth of the parliamentary arithmetic is that you can just about construct other combinations of parties that just about make up a parliamentary majority, there is no other combination of parties that gets you to the position of having a comfortable majority and that in the dicey economic situation tat the UK is in is important,” says Littlewood.

The Tories have also given ground in negotiations on Liberal demands for radical changes to the tax system. On this issue, Liberals are much more redistributionist – in favor of closing loopholes for people at the top and making reductions at the lower end of the tax stream – while Conservatives are regarded as having a more business friendly approach.

Crunch time is now approaching, but while the international markets have exhibited some jitters, investors have largely been giving breathing space to the political talks at Westminster.

Can Lib-Dem's Clegg make a deal?

Instead, says Littlewood, the overwhelming issue is whether the free-market-friendly Liberal leader, Nick Clegg, can now bring his party on board for a deal with the Tories.

“If all that was required was Clegg and Cameron to personally agree, a deal would have been signed,” he says. “Cameron appears to have delivered his party but Clegg has yet to deliver his, and it has quite a substantial wing that have fairly tribal loathing of the Conservatives.”

While markets are still not panicking at the absence of a new British government, Littlewood predicts that the situation is increasingly becoming a question of collateral political damage for the Liberal Democrats.

“The media narrative is now turning against the Liberal Democrats, asking them, 'Are you serious about propping up the Labour Party when it only got 29 percent of the vote?’ and ‘When are you going to make your mind up?’ ”